Since December, when American emerged from bankruptcy and combined with US Airways, its new stock (ticker: AAL) has risen 42%, almost four times the airline industry's 11% gain in that time. Bullish investors have focused on the fact that the reorganization will clear away $19.6 billion in the old American's debt, and that the merger has created the world's largest airline, with a nice balance of domestic (57% of revenue) and international services, and lots of opportunities to boost revenue and trim costs. Most importantly, it's another step, a giant one, in the consolidation of the U.S. airline industry—United is now linked to Continental,
Delta Air LinesDAL 0.7040654099477629%Delta Air Lines Inc.U.S.: NYSEUSD44.34
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(DAL) to Northwest, and
Southwest AirlinesLUV -0.3029468465987331%Southwest Airlines Co.U.S.: NYSEUSD36.2
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(LUV) to Airtran—which should provide the pricing stability that has long eluded the volatile industry.

AS IN ALL MARRIAGES, the honeymoon will soon give way to the day-to-day realities of living together. Previous airline mergers or acquisitions have virtually all had integration troubles—some lasting years—ranging from reservation-system breakdowns to annoying hub and route shifts to labor unrest and management squabbles that have resulted in many unhappy passengers. Investors in American also have to cope with the conversion of $20 billion of debt into about 530 million additional common shares, a dilutive process now underway.

The first US Airways jet to get a fresh coat of paint matching its new brand name.
Newscom

While acknowledging the risks, the new American executive team vows to do better than its rivals. "We're off to a great start," CEO Doug Parker, 52, said on a Jan. 28 conference call with investors. "The teams are working extremely well together, both at the management level and all of our employees out in the field," said Parker, the former US Airways chief who's well respected both inside the airline industry and by investors. (Barron's made the former US Airways one of its top picks for 2014 in anticipation of the combination. US Air holders received 28% of the new American Airlines.)

One admirer is Martin Sass, founder of money manager M.D. Sass, who's betting that American's management can handle any rough air. Despite the recent run-up, Sass insists the stock is cheap, selling at the lowest forward price/earnings multiple, 6.7, among the major U.S. carriers (see table in Takeoff! graphic). He notes that Parker and his US Air team integrated their much smaller merger nine years ago with Amwest very well. Says Sass: "It's a case of the well-managed minnow swallowing the poorly managed whale. There's a whole raft of things that need to be done. But Parker's the man for the job." The asset manager expects the shares to rise at least 20% from their recent $35, and says they could be worth much more in a couple of years.

PARKER AND CREW HAVE a lot to work with. American should generate an industry-best $43 billion in revenue this year. It has 81,700 employees and 599 transcontinental and 291 regional aircraft, with hubs in Chicago, Dallas, Los Angeles, Charlotte, Miami, and New York. American executives claim the carrier is No. 1 in the East Coast market, No. 1 in the Midwest, and No. 3 in the West. An American flight takes off or lands somewhere in the world every 13 minutes.

Andrew Davis, an analyst with fund giant and American Airlines shareholder T. Rowe Price, is eager to see what this new group can create. "Now, American Airlines is the largest of the main network carriers, with a very strong management team that goes from running the disadvantaged US Airways to a powerhouse with resources to regain corporate business and increase margins," he notes.

There are fewer brands flying the U.S. skies than at any time in recent memory. Having swallowed up much of their competition, American, Delta,
United-ContinentalUAL -0.7916959887403238%United Continental Holdings Inc.U.S.: NYSEUSD56.39
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(UAL), and Southwest now account for more than 80% of the nation's airline business, making it much harder—though not impossible—for an upstart carrier to rush in with a disruptive pricing plan.

"These consolidations have dramatically changed the industry," says Peter Pappas, founder of Aviation Advisory Network, a New York consultancy, and a former American Airlines executive. "The accomplished managers of these big companies operate their airlines much closer to full capacity in the face of growing demand. This will give them an ability to raise fares that they didn't have in the past."

Parker, who shaved costs amounting to 7% of revenue after US Air absorbed Amwest, is expected to do at least that much at American over time. Sass estimates Parker's team can squeeze out almost $2.5 billion in synergy savings, more than twice the $1.05 billion predicted by management in government filings. The new American plans to cut $4.3 billion in nonlabor costs over five years, 30% of that by reducing debt and interest payments, 35% by renegotiating deals with vendors and facilities, and 35% through revised terms for aircraft purchases and financing. American says its own "synergy" estimates are conservative. Its estimates of other financial items also seem cautious.

Scott Kirby, a long-time colleague of Parker who's now American's president, says the combined airline has "numerous revenue opportunities" that it's just starting to get its arms around. For example, American may be able to lure more business travelers—the largest airline-revenue generator—to Latin America by improving existing flight connections at its Dallas and Miami hubs. New York can become an even bigger center for trans-Atlantic traffic, postmerger. These and other "initiatives, when fully implemented, could be worth more than $400 million in annual earnings," Kirby said on the conference call. One other benefit: American's U.S.-heavy customer roster will be more inclined to travel as the economy gains.

The Bottom Line

Shares of the new American Airlines could climb more than 20% in the next year, on its way to a 50%-plus gain within a few more years.

Sass believes that American Airlines shares could be worth $53 in a couple of years. Putting a much higher multiple of about 11 times on his after-tax 2015 earnings estimate of $4.50 a share gives him a stock value of $49.50. Sass adds another $3.50 a share—the present value of more than $10 billion in net operating losses that can be used to reduce future taxes from the merger—to the price.

"Based on what we think they can earn in the coming years, their multiple is way too low," says Sass. Right now, American's 6.7 forward multiple is well below United's 7.9, Delta's 10.4, and Southwest's 13.6.

There's also $10 billion in cash that could go toward stock buybacks or dividends when the network rationalization process is complete.

IT WILL BE UP TO Parker to seize these opportunities, while addressing the substantial risks in the huge merger. The CEO has tried to get a jump on at least one of them by seeking labor support early on, something he wasn't very effective in winning when US Air made a hostile bid for a bankrupt Delta in 2006. This time, he has included labor in various parts of the deal before concluding the merger. "By having the pilots and the flight attendants and the unions on both sides signed onto a process, I think puts us leagues ahead" in implementing a successful merger, Kirby said on the call.

Employees get part of the giant stock distribution now occurring. It's a positive sign that the share price hasn't dropped through the distribution's first half; the final 50% should be distributed in the coming months. Even the bullish Sass concedes that the overhang could keep a near-term lid on American shares. But after that, the sky's the limit.

American's Initial Flight Plan

Here are management's seemingly conservative predictions from 2013 for the combined American-US Airways.